Wall Street Journal Says Default

The Case for an Irish Default

All roads to solvency lead through debt restructuring. It’s time for the Irish government to take heed.


The woes of Irish banks, unlike those at peer institutions elsewhere in Europe’s suffering periphery, are not a concern merely for the banks’ own solvency. They are a national solvency problem, too—or at least they became one when the government decided to insure bank creditors in September 2008.

It is this, more serious aspect of the Irish crisis that remains unaddressed in the government’s new bailout plans. Ireland’s public debt is clearly unsustainable. The projections contained in the International Monetary Fund’s bailout program see gross debt peaking in 2013, at 120% of GDP. Repeated infusions of taxpayer funds have not done much to convince the markets that those obligations will be repaid: Sovereign spreads are today about the same as they were in November, before the IMF program, and the latest plans have led at least one ratings agency to downgrade Irish sovereign debt.

Continued fiscal belt-tightening will help, but alone it can only take the country part of the way back to health. The government has already made heroic discretionary cuts since 2008, but the further turnaround required by the IMF is more self-sacrificing still: Under the terms of the bailout agreement, the primary fiscal balance is expected to move by 2015 to a surplus of 2% of GDP from last year’s deficit of 9%.

That requirement assumes, however, that the interest rate will exceed the growth rate by only two percentage points over the next four years—highly optimistic given that Ireland’s 10-year bond rate currently stands at about 10%. If, as is only slightly more plausible, the interest rate were to outpace GDP growth by six percentage points, the required primary surplus for 2015 would be 7% of GDP: a shift of 16 percentage points. And all that merely to stabilize the debt at 120% of GDP—to say nothing of reducing it.

Where, moreover, would growth come from? With ongoing fiscal consolidation, domestic demand will remain depressed. Trade will not provide much of a boost, either: Ireland’s real effective exchange rate, a measure of its import competitiveness, has already fallen by more than 10%. “Internal devaluation” cannot go much further, and given the European Central Bank’s present monetary-policy strategy, the euro is not likely to depreciate significantly.

The right policy is to restructure the debt, negotiating haircuts that would reduce its present value. A reasonable target, one in line with current market expectations, would be to cut the present value of the debt by €40-50 billion, or some 30% of GDP. That would bring the debt ratio down to a more sustainable 80% or so.

There might be contagion effects from this—on Greece, Portugal and perhaps Spain. But this is debatable, especially since the markets are already discounting debt restructuring at least for Greece. In any case, “solidarity” goes only so far when a fundamental national interest is at stake. The “solidarity” of Ireland’s partners in the euro zone is also limited, at least when it comes to the interest rate on the Irish borrowing and Ireland’s tax regime.

Note: Feasta is a forum for exchanging ideas. By posting on its site Feasta agrees that the ideas expressed by authors are worthy of consideration. However, there is no one ‘Feasta line’. The views of the article do not necessarily represent the views of all Feasta members.